Going by the doom and gloom that pervades the chatter in Mumbai, one would presume the equity markets would reflect a sorry picture. However, confounding that expectation, the markets have notched up a gain this calendar year. How did we get here & what explains this dichotomy? And, can we build on it?
The economy is not in good health, though we suspect the statistics are overstating the extent of slowdown. Corporate revenue, earnings growth and sales of autos, cement and durables suggest a slowing economy but nowhere as poorly off as official data indicates. The investment cycle has come to a halt and projects stalled continue to increase as government policy and administrative decision making have stalled. Inflation has stayed above the comfort level of the central bank and hence its reluctance to cut rates.
The failure of monsoon has led to gross domestic product (GDP) forecasts for the economy being cut to about 5.5 per cent for FY13. This leads to concerns about further pressures on the fiscal front and also inflation. The good news is that the government is holding well in excess of its buffer stock of food grains. However, oilseeds and pulses will likely see supply shortfalls, and imports are the only option. There are concerns the government will miss its fiscal targets. There is also the risk of upside pressure on spending for agriculture sector relief.
Given the list of concerns, the market’s performance this year is certainly a surprise. But remember, 2012 has been a surprisingly good year for equities around the world. The US economy, where growth has stalled, has returns in the mid-teens and Germany in the high teens with Europe itself mildly positive. India’s performance in 2011 was quite terrible and particularly so in USD terms due to the fall in the value of the rupee. Valuations came down to well below average in late 2011 and this has been the only supportive argument for Indian equities this year. So, some improvement in global risk appetite and supportive valuations have given Indian equities a nice bounce back.
The economic outlook for India remains challenging and the global environment uncertain. The country can muddle along for a while and hope for things to improve, but the risk of a stumble is high with such an approach. Investing in high quality businesses with sound balance sheets and healthy cash flows has continued to work well this year. For now, that remains the preferred approach, subject to valuations being reasonable for such businesses. The markets might continue to oscillate between below-average valuations and average for a while longer. For a move out of this area growth must improve. So, for now, we remain in the zone where valuations are supportive but macro challenges cap the upside. Tail risks on account of global and local uncertainties are also high. However, the only way to navigate this is to invest in companies that can weather a storm, rather than to worry about when the storm will hit. That has been our investing approach this year. And that, we believe, is the best way to deal with a challenging market in the near future.
The author is chief investment officer, Religare Mutual Fund
